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What is Foreign Sales Corporation

A foreign sales corporation (FiSC) is a part of the United States Internal Revenue System tax code that allows exporting companies to shield profits from taxation. The European Union (EU) and other U.S. trading partners viewed this scheme as a subsidy, and challenged it in the World Trade Organization (WTO). The WTO found the FiSC in violation of international trade rules, and in 2002 authorized the EU to impose trade sanctions totaling $4 billion on U.S. exports to the EU. In response to this pressure, the United States in 2006 revised the tax code related to FiSCs to comply with the WTO. The FiSC issue is the largest dispute that the WTO has ruled on to date, in terms of the amount of trade involved, and underscores the impact that globalization has on a country’s domestic policies.
The FiSC is a by-product of differences in tax policies among countries. The United States taxes U.S. businesses, not just on their domestic income but also on their worldwide profits. This includes both exports from the United States as well as sales of items produced at subsidiaries abroad. The United States taxes foreign corporations only on their income that derives from business conducted in the United States. Other countries apply different tax policies. For example, European governments do not tax the export revenues of European companies, exempting them from value added taxes (VAT). From the perspective of the U.S. government, U.S. companies were disadvan-taged in international business because the international sales of foreign companies sometimes faced a lighter tax burden, thereby allowing foreign companies to price their goods and services more cheaply than their U.S. counterparts. The FiSC, introduced in 1984, was intended to reduce this disadvantage. The legislation permitted companies to create off-shore subsidiaries (i.e., FiSCs) outside the United States (in places like the U.S. Virgin Islands or Guam), exempting at least 15 percent but no more than 30 percent of export income from taxes. Almost all major U.S. multinational corporations (MNCs) utilized FiSCs, as did many small and medium-sized companies. It is estimated that up to one-half of all U.S. exports were made through FiSCs.
The FiSC issue created little controversy until 1997, when the EU filed a complaint with the WTO. A WTO disputes panel ruled the FiSC to be an illegal subsidy and an appellate body agreed. Attempts by the U.S. government to replace the FiSC, including the 2000 Extraterritorial Income Exclusion Act (ETI), were unsuccessful, since the revised tax regimes also violated WTO rules. Since the WTO permits member countries to impose trade sanctions against other members not abiding by the organizations decisions, the EU drew up a list of products exported from the United States to Europe that would face increased tariff levels. The WTO estimated that U.S. companies received about $4 billion in tax benefits annually from the FiSC program. Thus, the EU was permitted to collect an equivalent amount in additional tariffs from U.S. exports to Europe, and did so between March 2004 and January 2005. Finally, in May 2006 the U.S. Congress passed tax legislation that included the repeal of the FiSC and ETI, thereby ending this international trade and tax dispute.
The issue of FiSCs is important to international business for three reasons. First, it illustrates how globalization makes it increasingly difficult to separate domestic policies from international policies. In the FiSC case, domestic tax policy became an international issue once it became clear that it was being devised to enhance the economic competitiveness of U.S. MNCs. Second, the resolution of the FiSC dispute highlights the growing importance of international organizations like the WTO and EU in shaping the international business environment. Although countries create organizations such as these to facilitate international business, they sometimes find themselves constrained by the rules and procedures they put in place. Third, the United States and the EU are each other’s most important trade and investment partner. Yet, despite this close relationship, disputes over FiSCs, the safety of genetically modified organisms, subsidies to the aerospace industry, and other issues often overshadow the economic links and strain political relations.